While the American Taxpayer Relief Act of 2012 (ATRA) finally ended more than a decade of "temporary" Alternative Minimum Tax (AMT) patches and fixes that kept expiring and had to be renewed, the ultimate resolution of ATRA was not permanent repeal of the AMT. Instead, ATRA provided permanent "relief" by merely locking in the latest AMT exemptions from 2011, and adjusting the exemption - and everything else under the AMT system - for inflation going forward.

As a result, high-income individuals continue to be potentially exposed to the AMT, depending on exactly what their income levels may be, and the AMT adjustments and preference items that have to be added back to income for AMT purposes. Fortunately, though, a client's AMT exposure can actually be quickly evaluated by looking at a chart that maps income after deductions, and the amount of deductions that are lost for AMT purposes, to figure out what combinations of income and lost deductions will result in an AMT liability.

Notably, though, being exposed to the AMT is not always a "bad" outcome. In fact, because the top AMT tax rate is "only" 28%, in some cases high income individuals will actually want to accelerate more income into an AMT year. In an AMT environment, the primary planning opportunity is actually to manage income around the AMT "bump zone" - that span of income where the AMT exemption is phased out, temporarily boosting AMT rates (and capital gains rates!) by an extra 7%. For those below the AMT bump zone, the goal is to spread out income to stay below the zone. But for those above the AMT bump zone, it turns out the best strategy to reduce the long-term bite of the AMT may actually be to pay even more in taxes!

Wednesday, April 9th, 2014 Posted by Michael Kitces in Taxes | 1 Comment

The Internal Revenue Code allows individuals who receive a distribution from an IRA to avoid tax consequences by rolling the funds over to an IRA within 60 days. However, to avoid abuse of the rule, the tax code prescribes that taxpayers can only complete an IRA rollover once in a 12-month period, which the IRS in the past has interpreted to apply to IRAs on an account-by-account basis. In turn, the "separate accounts" treatment of the IRA rollover rule potentially allows taxpayers to chain together multiple IRA rollovers, in an attempt circumvent the 1-year rule and gain "temporary" use of IRA funds for an extended period of time.

However, a recent Tax Court case, Bobrow v Commissioner, has shut down the separate IRAs rollover strategy altogether. In a case that started out as a taxpayer who botched a version of the sequential separate accounts rollover strategy, and drew the IRS' ire in the process, ended out with a finding of guilt for not only of botching the rollovers but having the Tax Court (re-)interpret IRC Section 408(d)(3)(B) as well. In the decision, the Tax Court applied the 1-year IRA rollover rule to apply in the aggregate across all IRAs, invalidating the separate IRA rollover treatment not only for Bobrow but all taxpayers as well!

In the aftermath of the Bobrow case, the IRS has now issued IRS Announcement 2014-15, stating that it will acquiesce to the Tax Court decision, update its Proposed Regulations and Publication 590, and issue new Proposed Regulations soon that will definitively apply the 1-year IRA rollover rule on an IRA-aggregated basis going forward. However, to allow time for transition - including taxpayers in the midst of rollovers left in the lurch, and IRA custodians who must update their own processes and procedures - the IRS has declared that the "existing" rules will be allowed through the end of the year. However, the new rules allowing only one IRA rollover in a 1-year period will be effective starting January 1, 2015 (potentially dating back to IRA rollovers that occur in 2014), so advisors and their clients should plan accordingly!

Wednesday, March 26th, 2014 Posted by Michael Kitces in Taxes | 0 Comments

The basic benefit of tax deferral on investment growth is relatively straightforward: by not paying taxes, money that would have otherwise gone to the government instead can remain invested for future growth. To the extent the money will ever be spent, the taxes must eventually be paid, but as long as additional growth can be generated in the meantime, that is a value for the investor. As a result, investors often focus on deferring capital gains, and reducing the rate of portfolio turnover.

Yet a deeper look at the actual economic value of tax deferral reveals that most of the benefit is actually lost with even low levels of turnover. An investment that changes just once a decade actually forfeits more than half of the tax deferral benefits over the span of 30 years, and for a portfolio with dividends as well, a mere 10% turnover forfeits more than 2/3rds of the tax deferral value. In a lower return environment, the true tax deferral benefit of extending the average holding period of an investment from 2 years to 5 years - chopping the portfolio turnover rate from 50% down to 20% - is actually less than 5 basis points, which can be made up in the blink of an eye through a lower cost investment change or a mere day's worth of relative returns (not to mention weeks, months, or years)!

In turn, these results suggest that in the end, investors may be grossly underestimating the damage that's done by having any portfolio turnover, and grossly overestimating the value of trying to add several years to the average holding period of an investment. Of course, high turnover investing has other costs as well, and the results don't necessarily mean that rapid trading will be fruitful. Nonetheless, the limited value of tax deferral even for an investor with a decade-long average holding period suggests that investors should be highly cautious not to sacrifice prudent investment decisions upon the altar of low-turnover tax efficiency, and that it may even be time to reconsider asset location decisions and whether equities should be held in tax-deferred accounts instead.

Wednesday, March 5th, 2014 Posted by Michael Kitces in Taxes | 4 Comments

The benefits of reducing current tax liabilities through tax loss harvesting are widely acknowledged - so much, that the IRS developed the 30-day "wash sale" rules to prevent taxpayers from abusing the strategy. Yet less widely understood is that there's one crucial caveat to tax loss harvesting - that taking advantage of the loss also reduces the cost basis of the investment, potentially exposing the taxpayer to a gain in the future that can wipe out some, most, or all of the tax benefit, and in the extreme with today's four capital gains tax brackets actually drive up future tax rates and leave the investor worse off than having done nothing at all.

Notwithstanding these issues, many investors and advisors continue to overstate the benefits of tax loss harvesting, and now "robo-advisor" Wealthfront is doing so as well, with its "Tax-Loss Harvesting White Paper" that purports Wealthfront can increase an investor's wealth by an extra 1%/year, annualized, indefinitely, through its daily tax loss harvesting strategy. Unfortunately, though, the reality is that in a review of its strategy, Wealthfront - like so many others - is confusing tax savings with tax deferral, and in the process may be drastically overstating its benefits by a factor of 10:1, and for its typical investor the true annual benefit may be a mere 1/25th of what their "white paper" claims purport.

Again, this is not to say that tax-loss harvesting is useless, and in reality while many advisors have been automating tax-loss harvesting just like the robo-advisors for almost a decade, Wealthfront's particular tools to implement loss harvesting are unique, especially in how it is able to quasi-pool investor assets to drive the transaction costs down to nothing for its clients (facilitating tax loss harvesting at very small thresholds on a nearly continuous basis!). Nonetheless, the flaws of the Wealthfront tax-loss harvesting white paper also provide a clear example of the problems with trying to come up with a generalized algorithm for an individual's specific and unique tax circumstances, and overall provides an unfortunate case study in how not to calculate tax alpha and try to apply its benefits for a wide range of clientele.

Wednesday, February 5th, 2014 Posted by Michael Kitces in Taxes | 4 Comments

While Roth IRAs are very popular as a retirement savings vehicle due to their tax-free growth treatment, they also have several unique rules associated with them to ensure that their favorable tax status is not abused. In particular, there are two different 5-year rules associated with Roth accounts to prevent them from being taken advantage of; the first 5-year rule applies to Roth contributions and determines whether earnings will be tax-freewhile the second 5-year rule applies to Roth conversions and determines whether conversion principal will be penalty-free.

Each of the 5-year rules are measured from the beginning of the tax year for which they apply, which means in reality tax-free earnings or penalty-free conversion principal may be accessible in less than 5 years in certain circumstances. And because the Roth rules aggregate all accounts together for the purposes of determining the tax treatment of various distributions, it's necessary to track the various 5-year rules and the amounts they're associated with, regardless of whether they are held separately or mingled together into a single account.

Ultimately, being able to effectively navigate the various Roth 5-year rules creates several planning opportunities as well. For some, taking advantage of the Roth conversion 5-year rule is a way for those well under age 59 1/2 to tap their IRA funds "early" without an early withdrawal penalty. For others, the reality is that the Roth conversion 5-year rule is a moot point anyway, because they already meet another exception to the early withdrawal penalty (e.g., already being over age 59 1/2). However, in all cases, the 5-year rule for contributions must be met before any Roth earnings can actually be tapped tax-free; fortunately, though, because any first-time contribution or conversion can start the clock, clients who are concerned about the 5-year rule can make a contribution to a Roth (or to a traditional IRA and then convert it) to start the time window now, and ensure they'll never need to worry about it in the future!

Wednesday, January 1st, 2014 Posted by Michael Kitces in Taxes | 6 Comments

While charitable giving should always be done first and foremost for charitable and not tax purposes, the Internal Revenue Code does afford a number of different tax strategies for charitable giving. In recent years, the opportunity to complete "Qualified Charitable Distributions" (QCDs) directly from IRAs to a charity have been especially popular, in part because QCDs not only allow for "spending" amounts in IRAs without ever paying any taxes, but also because QCDs satisfy an individual's Required Minimum Distribution (RMD) obligations (and since QCDs are only available to those over age 70 1/2, there must be an RMD to satisfy!).

However, the reality is that while QCDs from IRAs do have favorable tax treatment, they are generally still less favorable than donating appreciated securities to satisfy charitable goals. While the former allows for entirely pre-tax charitable contributions (directly from an IRA), the latter effectively provides a "double tax" benefit, as contributions are deductible (making them pre-tax) and donations of appreciated securities permanently avoid taxes on the associated capital gains. As a result, while QCDs from an IRA are better to satisfy charitable goals than just writing a check or giving cash, using appreciated securities is still better (and the greater the appreciation, the more they come out ahead!).

Notwithstanding this difference in treatment, QCDs are still preferrable in situations where the deduction for donating appreciated securities might be limited - for instance, if the deductions in total will exceed the charitable contribution AGI limits (including the 5-year carryforward), where deductions have been already capped at 80% due to the Pease limitation, or for those who have so little in the way of itemized deductions that it would be better for them to simply claim the standard deduction (and donate separately via QCDs if desirable). And of course, sometimes the dollar amounts involved simply don't make it worthwhile to go through the hassle of donating appreciated securities. Thus, ultimately, whether QCDs or donating appreciated securities will be more tax-efficient depends upon the facts and circumstances of the situation; nonetheless, all else being equal, QCDs still tend not to be the best charitable giving option available!

Wednesday, December 18th, 2013 Posted by Michael Kitces in Taxes | 1 Comment

As the end of the year approaches, so too does the time for end-of-year tax planning, a time typically filled with strategies that minimize income, maximize deductions, and generally try to ensure that the least amount of taxes possible are paid and that any taxes due are pushed as far out into the future as possible.

In the past, a minimize-and-defer-income approach has been rather effective. But in today's tax environment, with more tax brackets, higher top rates, and a myriad of additional phaseouts and surtaxes that can drive marginal tax rates even higher for both ordinary income and long-term capital gains, the reality is that just pushing income indefinitely into the future is not necessarily the best strategy anymore. Instead, deferring too much income into the future may simply mean that when it's finally time to liquidate - whether it's selling highly appreciated investment positions for retirement income, or beginning withdrawals (or facing RMDs) from large IRAs - income at the time can rise so high that tax rates skyrocket!

As a result, it turns out that in today's environment, it may be far more effective to consider strategies like Roth conversions or capital gains harvesting that aim to accelerate income into the current year, rather than defer it into the future. This form of "tax bracket arbitrage" - creating wealth by reporting income when tax rates will be lower, even if it's now -  can actually result in greater lifetime wealth, even though it triggers a tax liability sooner rather than later! In other words, it turns out that sometimes the best way to save on taxes is to pay them as soon as possible, even if it means creating income before the end of the year in order to do so!

Wednesday, December 11th, 2013 Posted by Michael Kitces in Taxes | 4 Comments

The Pease limitation, which restricts the amount of itemized deductions a taxpayer can claim, has been around for more than two decades; after briefly being phased out and repealed at the end of last decade, it has returned in full force for 2013 as a result of the American Taxpayer Relief Act of 2012. The reinstatement of the Pease limitation applies with the same rules that existed previously - phasing out itemized deductions by 3% of every dollar over the threshold - though the new rules did increase to the threshold to a new, higher amount.

Given how the Pease limitation is calculated though - as a percentage of income above the threshold, and not directly based on deductions - the reality is that the Pease limitation should actually more properly be viewed as a surtax on income, not a limitation on deductions. Although the amount of deductions does matter in certain limited circumstances - particularly with ultra-high-income taxpayers living in states with no state income taxes - for most, the Pease limitation simply lifts the top 3 tax brackets by about 1% - 1.2% without directly impacting the benefits of tax deductions at all!

This distinction of whether the Pease limitation is driven primarily by income or by deductions is important, as it affects the relative value of various income and deduction strategies. In fact, while the common conclusion from the media and some political pundits has been that the Pease limitation is a disincentive to tax deduction strategies like charitable giving, the reality is actually that there are only a few limited circumstances where the benefits of charitable giving may be diminished indirectly by the Pease limitation, and in the end the overwhelming majority of individuals who face the Pease limitation will actually still enjoy the full tax benefits of their charitable giving strategies!

Wednesday, November 27th, 2013 Posted by Michael Kitces in Taxes | 5 Comments

As 2014 approaches, the new health insurance exchanges will begin their open enrollment, and along with the new exchanges will come the premium assistance tax credit, intended to make health insurance purchased on an exchange more affordable for the "lower income" - which is actually broadly defined to include everyone up to 400% of the Federal Poverty Level. As income rises, the premium assistance tax credit is slowly phased out, until eventually it provides no benefit at all.

However, the reality is that because the premium assistance tax credit phases out as income rises, it indirectly serves as a surtax that triggers higher marginal tax rates for those who are phasing the credit out. And the marginal impact is actually quite significant; at relatively modest levels of gross income from $25,000 to $50,000 of income, the premium assistance tax credit effectively doubles the marginal tax rate (to more than 30%) for those who are purchasing health insurance from the individual exchange. For older households that are claiming Social Security early, but still obtaining health insurance from an exchange (as they're not eligible for Medicare yet), the effect can be even more severe, as marginal tax brackets, the phaseout of the premium assistance tax credit, and the phasein of Social Security taxability all overlap.

The end result doesn't mean that it's a good idea to avoid generating income - the marginal tax rates are significantly higher than just the individual's tax bracket, but nowhere near 100% tax rates. Nonetheless, the introduction of the premium assistance tax credit may mean a whole new level of in-depth year-to-year tax planning for those with relatively modest incomes, who can be subject to surprisingly high marginal tax rates under the new rules.

Wednesday, October 9th, 2013 Posted by Michael Kitces in Taxes | 7 Comments

The premium assistance tax credit, established under IRC Section 36B as a part of the Affordable Care Act (also known as "Obamacare"), takes effect in 2014, and is intended to help make health insurance more affordable by providing a tax credit to subsidize the cost of insurance for “lower” income individuals.

In practice, though, the introduction of the premium assistance tax credit creates a new series of rules that financial planners must be aware of, for a wide range of clients who may potentially be eligible for the credit, which can apply for individuals with income up to $45,960 and a family of four earning $94,200 (in 2013, and adjusted annually for inflation). And given the dollar amounts involved for the credit itself (which can be worth several thousand dollars to a family), the ramifications of effective health insurance tax credit planning can be significant.

While the new health care rules have been controversial, with the new health care exchanges opening for enrollment on October 1st (albeit with some technology glitches and speed bumps so far!), the time is now for advisors to begin to get familiar with the new rules and some of their tax planning implications. For some uninsured clients, this may represent their first opportunity ever to get access to health insurance without medical underwriting - and with a premium subsidy to help - creating a newfound flexibility for employment and retirement decisions. For others, it will be important to comply with the new rules simply to avoid the potential penalties under the so-called "individual mandate."

Wednesday, October 2nd, 2013 Posted by Michael Kitces in Taxes | 6 Comments

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Wednesday, April 23rd, 2014

Understanding the New World of Health Insurance Evaluating Existing Annuities: What Every Adviser Needs to Know @ FPA New Jersey

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Monday, April 28th, 2014

Safe Withdrawal Rates: Mechanics, Uses & Caveats @ St. Louis Estate Planning Council

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